Inventory is also called stock in trade, or just stock.
The IFRS definition of inventory is brief, let’s add some juice (if that is possible in accounting, and off course it is possible!!) or look at it as being in business.
Inventories consist of the value of materials and goods held by an entity:
- to support production (raw materials, subassemblies, work in process),
- for support activities (repair, maintenance, consumables), or
- for sale or customer service (merchandise, finished goods, spare parts).
Inventory is often one of the largest items in the current assets category, and must be accurately counted and valued at the end of each accounting period to determine a company’s profit or loss. However, using the current days Enterprise Resource Planning (ERP) automation software systems means counting it not that necessary anymore.
Inventory keeping Inventories – the highlights
Organizations whose inventory items have a large unit cost generally keep a day to day record of changes in inventory (called perpetual inventory method) to ensure accurate and on-going control. Organizations with inventory items of small unit cost generally update their inventory records at the end of an accounting period or when financial statements are prepared (called periodic inventory method).
ERP provides an integrated and continuously updated view of core business processes using common databases maintained by a database management system. ERP systems track business resources—cash, raw materials, production capacity—and the status of business commitments: orders, purchase orders, and payroll. The applications that make up the system share data across various departments (manufacturing, purchasing, sales, accounting, etc.) that provide the data. ERP facilitates information flow between all business functions and manages connections to outside stakeholders.
Sales matching costs of sales Inventories – the highlights
In general inventory is recognised as an asset of the entity until the related revenues are recognised (ie the item is sold and this sales transaction is recognised as revenue and trade receivable) and the inventory is recognised as an expense (ie recorded as cost of sales and derecognised from inventory). In other words, the matching principle as one of the fundamental accounting assumptions requires costs (not being period cost!) to be matched with associated revenues. In order to achieve this, costs incurred for goods which remain unsold at the year end must be carried forward in the statement of financial position and matched against future revenues.
Impairment of obsolete inventory Inventories – the highlights
Part or all of the cost of inventories may also be impaired if a write-down to net realisable value is necessary (the measurement of inventories is ‘Inventories should be measured at the lower of cost and net realisable value.’).
Obsolescence is the state of being which occurs when an object, service, or practice is no longer wanted even though it may still be in good working order. Potential reasons for obsolescence are:
- The most simple reason for obsolescence is the ‘use by’ or ‘best before’ date on food and drinks.
- A second good reason is Spring/Summer and Fall/Winter seasons in fashion stocks. Now-a-days the fashion industry is even designed to make consumers feel ‘out of trend’ after one week! But the idea is if fashion merchandise is not sold quickly enough it gets obsolete. Spanish retailer Zara pioneered the fast-fashion concept with new deliveries to its stores coming in twice per week. H&M and Forever21 both get daily shipments of new styles, while Topshop introduces 400 styles a week on its website.
- Most Slow-moving and Obsolete stock comes from new-product launches that don’t quite meet expectations.
- Other reasons might be technological development – in some industries new products get created to replace competing or older products at a higher speed than in others.
Cost formula Inventories – the highlights
The IAS also provides guidance on the cost formulas that are used to assign costs to inventories. The cost of inventories should be assigned by using the first-in, first-out (FIFO) or weighted average cost formulas. The LIFO formula (last in, first out) is not permitted by IAS 2.
IAS 2 provides that an entity should use the same cost formula for all inventories having similar nature and use to the entity.